Cost Accounting & COGS in the Cannabis Industry
Suppose you own and operate a legitimate business in accordance with your state’s laws in a rapidly growing and lucrative sector… Sounds like a win-win, right? Unfortunately, for business owners in the cannabis industry, it doesn’t always feel that way.
Cannabis-related businesses are often misunderstood, misrepresented, and underserved by the merchant and professional services community. For example, if you have access to industry-specific software and point-of-sale systems at all, using them often leaves you feeling like the victim of a never-ending beta test, forever subject to working through the glitches. Without access to federally insured banking, you’re also juggling the risks involved in handling large amounts of cash.
You have to remain on high alert due to complex and disparate federal, state, and local laws and regulations and complex reporting and compliance requirements. In combination with the overzealous scrutiny from regulatory agencies, it’s challenges like these that solidify why understanding cost accounting is essential in the cannabis industry.
What is cost accounting?
In a general sense, cost accounting is pretty straightforward. It’s the documentation, analyzation, and categorization methods you use to account for the fixed and variable costs incurred by your business in providing your product or service. It helps you ensure efficiency, productivity, and reliable data for forecasts and projections.
Cost accounting includes the method you use to determine the cost of goods sold (COGS), which is tax deductible. In turn, it helps you ensure your business is not losing profit by overpaying taxes.
What’s different about COGS for cannabis-related businesses?
Cannabis-related businesses are only allowed to deduct the COGS from gross receipts under IRC §280E, which states, “No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business [...] consists of trafficking in controlled substances [...] which is prohibited by Federal law or the law of any State in which such trade or business is conducted.” As is the case with many other issues for cannabis businesses, this leaves business owners at the mercy of disparate and murky federal, state, and local guidance.
While the allocation method allowed under IRC §263A may be more favorable, current case law limits cannabis companies to IRC §471 for calculating COGS. However, the Tax Cuts and Jobs Act (TCJA) included text allowing small business taxpayers with less than $25M in revenue to avoid use of the accrual method of accounting.
What does this mean for your cannabis company?
Under the TCJA, the IRS is disallowed from changing the inventory accounting method used by the taxpayer under audit as long as the company’s method of treating inventory is supported by the taxpayer’s books and records. The method you use to determine COGS depends on your tax status, method of accounting, and what exactly it is you do. For example, COGS will be determined differently for cultivators than for dispensaries. But, in some cases, changing your accounting method may reduce your taxable income.
Ultimately, taking advantage of the tax deductions commonly available to other types of businesses is often more challenging or even unobtainable for cannabis-related businesses. That’s why it’s so important to maximize the deductions that are available to you. I help cannabis-related business owners determine COGS and maximize their related deductions. If you’re ready to learn more, contact me today.
Karla Brannen is a discerning provider of tax planning and compliance services, including services bearing multi-state intricacies. Her panoramic approach to bookkeeping and CFO services enables her to address multi-faceted and unique client needs. Karla works with individuals, their trusts and estates, and small businesses, and she provides tax filing services for employee benefit plans.